A tale of two disruptions

Brexit and the Trump presidency are routinely described as parallel manifestations of the same anti-establishment mood. This account is generally offered by people who oppose both events and are sceptical of their potential to achieve anything positive, either in economic or other terms. Whilst this position is perfectly defensible and may even have sometimes appeared vindicated by the course of events, there is no reason to give its predictions the status of truth, as much economic commentary since mid-2016 has done.

Indeed, even the interpretation of both phenomena is hotly disputed. To many, including most of those who form the policy establishment, Brexit and Trump represent opposition to globalisation, immigration and the cultural liberalism characteristic of large metropolises such as New York and London. To many others, they are an auspicious demonstration of people wresting back control from elites for salutary purposes, whether to curtail the power of unelected bureaucracies, liberalise the economy or lower taxes.

What is clear is that, contrary to the bulk of editorial copy at the end of 2016, the year that has just closed did not bring economic and geopolitical Armageddon. One may quibble with the extent to which Brexit and Trump have improved over the status quo ante, but the psychological earthquake they constituted to many has not yet been replicated in policy terms.

2017 did however illustrate an important contrast which will likely persist as the two events continue to shape legislation on either side of the pond. In Britain, the emphasis has clearly been on proving that continuity and certainty can be supplied even as the ostensible goal of Brexit – “take back control” – is pursued. Hence the UK government’s rhetorical equivocations as to whether it would leave the EU single market (a regulatory area membership of which is required to have free trade in services) and customs union (which would preclude the UK from signing its own trade agreements). It appears no is the definitive answer to both.

By contrast, in America the new administration has been at pains to demonstrate its disruptive credentials. Every policy cause that Trump has championed has been a big shift, whether the ill-fated defenestration of Obamacare or the vastly overshot target of eliminating two regulations for every newly introduced one. See figure 1

The last major economic policy item of the year in each of the two countries highlights this disparity. Whereas the US Congress closed 2017 by passing the most significant tax reform package since 1986, in Britain Chancellor Philip Hammond introduced a budget that was modest in ambition and conspicuously avoided the great challenges facing the British economy.

Let’s start with the latter. After an acute recession in 2008/09 and a tepid recovery up to 2013, the British economy had been the strongest-growing of all major developed countries. Unemployment, even during the crisis, had remained comparably low and was declining strongly. Wages, whilst growing feebly, remained stable in purchasing power thanks to low inflation. Worker productivity was the great disappointment, having been consistently below other European economies and grown less strongly since 2007.

The Brexit vote has so far changed expectations but not economic outcomes. Job creation has remained strong and the employment rate of 15- to 64-year-olds is at a record 74.6 per cent. As the pound sterling dropped by 10 per cent vis-à-vis the US dollar and 14 per cent to the euro after the EU referendum, exports are up. So is inflation, but a tighter labour market means real wages are starting to rise faster. All of this has persuaded the Bank of England to begin raising short-term interest rates, despite Brexit, albeit more cautiously than the Fed. Britain’s economic problems are not macroeconomic but rooted firmly in the supply side. In brief, the cost of living is much too high, which grates at consumers, particularly those making the median UK household income of £27,200 ($36,900) or less. The source of much of the trouble is the housing market. House price to income ratios, a common measure of affordability, are at a record 7.7 in England and a breath-taking 14.5 in London. No wonder that a sharp generational divide has emerged in recent years, with over-65s two to three times as likely to be homeowners as those in their 20s and 30s.

The culprit is onerous planning regulations. Given the UK’s highly centralised system of government, local communities bear all of the costs – congestion, pressure on local services, a more cluttered landscape – but only a fraction of the benefits – higher tax revenue, the ability to provide a larger and more diverse set of public services – from housebuilding. Thus NIMBYism is the order of the day. An Englishman’s home is his castle, but an ever smaller number of people are having a say over everyone else’s castles, too.

Nor is the deleterious impact of planning restrictions limited to housebuilding. Scarce commercial space means groceries and clothing are more expensive. Regulation raises the cost of welfare programmes, since they are tied to the cost of living. Infrastructure planning has also become a nightmare: the expansion of London’s Heathrow airport was first identified as a pressing need in the late 60s, yet the additional runway is only scheduled to be completed in 2025.

It is in this context that the government’s timid initiatives in the latest budget must be examined. The Chancellor announced that first-time buyers purchasing a house worth up to £300,000 ($407,000) would be exempt from stamp duty land tax. Although most new homeowners will be covered by this measure, it is unlikely to make a dent on prices as demand will rise, simply making those selling their home richer. The rest of the programme is uninspiring: tax thresholds will rise in line with inflation; the National Health Service, the UK’s state-run healthcare behemoth, will secure a funding boost; a raft of fashionable railway and R&D projects will be given more subsidies.

All of this will be tempered by a considerable scaling down of growth forecasts, in line with the medium-term supply shock of Brexit. Thus GDP growth is expected to average 1.4 per cent for the next four years, and productivity growth will slow further. Inflation will gradually drop to the long-term target of 2 per cent per year, and government borrowing will also decline thanks to continued to job creation. A mixed picture far more promising than the post-Brexit forecasts of doom and gloom – but nothing to elicit bullishness about the prospects of the UK economy.

How about the US? It is fair to say that the early 2017 rally spawned by expectations of an infrastructure boom has tapered off, although the S&P 500 is up 20 per cent since Trump’s inauguration and the market has accommodated the Fed’s rate rises with nary a hiccup. The year was periodically punctured by reports of the President’s intemperate ejaculations on Twitter, but beneath the surface, good things have been happening.

There has been a step change in regulatory policy, going much beyond the two-for-one rule and illustrated by Trump’s appointments to key regulatory agencies such as the EPA (environment), the FCC (telecoms and internet) and the SEC (capital markets). Not only are proposed rules sharply down, but there is a refreshing emphasis on the cost as well as the touted benefits of regulation. With the number of restrictions in the Code of Federal Regulations at an all-time high of 1.1 million, this change of stance had been long overdue.

The calendar year in America ended with a legislative bang as Congress passed a sweeping tax reform. Nothing of the kind had happened since the Reagan administration. The law has been portrayed as a giveaway to the rich and corporations, but this is a misrepresentation: whilst it is reported that two-thirds of the tax savings will accrue to the top quintile of US earners, this income group is responsible for 69 per cent of all income taxes paid. On this measure, the tax reform in fact gives a disproportionate share of the tax savings to lower-income groups.

In addition to cutting most marginal income tax rates by two to four percentage points, the package will lower the corporate income rate from 39.1 per cent to 21 per cent, which will turn the US from the G20 country with the highest statutory tax rate on corporate profits into one of the lowest-taxing. Additionally, the corporate tax will go from worldwide to territorial. This is significant because the worldwide system had discouraged large US multinationals from repatriating profits so as to defer their liabilities. Nor are the benefits from these changes restricted to owners of capital: studies have shown that as much as 60 per cent of the CIT burden falls on workers in the form of lower wages.

Among other measures, the tax package limits the mortgage interest deduction – which induces homebuyers to borrow more – and it eliminates the penalties introduced under President Obama’s healthcare reform for those who refrained from buying health insurance. In all, it is a momentous reform even if it has divided politicians and economists. The latter worry about the package’s impact on government borrowing, which is estimated to increase by $1.5 trillion over 10 years as a result of the Trump bill. Large and persistent deficits are problematic, not only because they compromise the government’s commitments and the soundness of the currency, but also because taxpayers will anticipate future tax hikes to repay the debt, thereby weakening the income boost from tax cuts today (so-called Ricardian equivalence). Nevertheless, the Tax Foundation expects the reform to raise GDP growth by 0.3 percentage points per year over the next 10 years.

Deficit reduction was long a policy objective of Britain’s Conservative government, but its resolve to reduce expenditure weakened as soon as the economy’s prospects brightened from 2013. Brexit and its expected short-term headwinds have further animated the government’s Keynesian propensities. By contrast, the Trump administration has (probably excessively) touted the tax reform’s growth effects as offsetting its static impact on the national debt.

The rhetoric of pro-Brexit politicians and the 45th American President has divided voters. But their true test will be to deliver on the twin promises of sovereignty and prosperity. The way they have gone about it so far, however, could not have been more different.

Diego Zuluaga is head of Financial Services and Tech Policy at the Institute of Economic Affairs.